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ISO New England phases in pay-for-performance incentives to keep the lights on

Six years after first proposing the forward capacity market reforms, ISO New England implemented "pay-for-performance" incentives aimed at ensuring energy resources are ready and able to fulfill their obligations to provide electricity or reduce demand during times of stress on the power system.

The carrot-and-stick reward system will replace the region's winter reliability stop-gap program that required dual-fuel capable generators to stockpile oil or liquefied natural gas on-site.

ISO-NE first floated pay-for-performance incentives, an attempt to improve poor generation response rates during times of need, in a 2012 white paper responding to a growing number of power outages. The Federal Energy Regulatory Commission approved them in 2014.

For similar reasons, the PJM Interconnection developed a similar pay-for-performance program after the January 2014 polar vortex tested the U.S. bulk power system. FERC approved those reforms, to be transitioned in over five years, in June 2015. However, PJM is considering making further reforms, this time to its energy markets, to improve price signals in a way that could benefit more expensive and inflexible generating units such as nuclear power.

Since 2006, New England power plants that cleared the forward capacity market received payments in exchange for their promise — referred to as a capacity supply obligation — to generate electricity when dispatched during a shortage event. Demand-side resources with a capacity supply obligation are required to reduce the consumer demand for power if dispatched during shortage events as well.

However, ISO-NE came to realize that the forward capacity market's original penalties for nonperformance during a shortage event were too small. The definition of a shortage event — when the supply of electricity is insufficient to meet consumer demand plus reserve requirements — was also so narrow that only two such events were declared in 12 years, the grid operator said on its blog.

"Resource owners received their monthly capacity payments whether they were capable of meeting their [capacity supply obligation] or not," said ISO-NE. "The weak link between capacity payments and performance provided little incentive for owners to invest in their resources to ensure that they were capable of providing energy and reserves when needed."

ISO-NE said the resulting lack of investment in existing resources posed a challenge to maintaining power system reliability, especially during extremely cold winter weather. For instance, the grid operator noted that resources that failed to meet their obligations did not have firm contracts for fuel delivery, were not fully staffed and did not maintain their facilities.

In addition, ISO-NE said some dual fuel-capable natural gas-fired generators no longer maintained their ability to burn stored reserves of oil when they could not receive natural gas supplies, especially during cold winter weather when heating demand is high. Other, older oil- and coal-fired power plants that rarely operated also had mechanical difficulties when trying to start, said ISO-NE.

The ninth forward capacity market auction, which was held in February 2015 for the 2018-2019 capacity commitment period, was the first auction to incorporate the pay-for-performance requirements.

ISO-NE expects that the new incentives will encourage resource owners to make the arrangements and investments needed to ensure their resources perform as promised. It also anticipates that the two-stage incentive program will improve system reliability at the lowest cost in the long term and facilitate the replacement of older, unreliable generating resources with newer, more efficient generating resources.

The new incentive payments are being phased in over the next six years, and full implementation is slated for June 2024. Pay-for-performance payments start at $2,000 per megawatt-hour from June 1, 2018, through May 31, 2021, before increasing to $3,500/MWh from June 1, 2021, through May 31, 2024, and then $5,455/MWh from June 1, 2024, onward.

The system's two-stage settlement aims to ensure ratepayers are not held liable for the costs of underperforming resources. The first-stage pays suppliers their monthly capacity payments but then subjects them to a second settlement based on their actual performance during times of scarcity. Resources that perform poorly cover their forward obligations by paying the resources that had to overperform to pick up the slack.

"Time will be needed to assess whether [pay-for-performance], especially its phased-in payment plan, will be sufficient to address the region's growing fuel-security risks," said ISO-NE.